"Don't fight the Fed," the well-worn adage goes. But when the most accurate predictor of Federal Reserve action -- the fed-funds futures contract -- shows uncertainty within a week of a monetary policy meeting, what should you believe about the Fed's next rate move? More importantly, how can you position yourself in the near term to take advantage of the Fed's most likely action?
This week, the media and pundits alike have been discussing how a weakening economy will prompt the Fed to cut rates as much as 50 basis points at its meeting Tuesday. But nearby fed-funds futures contracts, the best forecasters of Fed action in the days before a meeting, are showing about a 50% chance of a 25-basis-point rate cut. Because the market isn't helping us determine what will happen Tuesday, we need to look more closely at the Fed itself. Two trends have characterized the Fed in recent years. First, the central bank has strived to become more transparent, attempting to telegraph its intentions before changes in monetary policy. Two, the Fed has attempted to be a gradualist, hiking or cutting rates in quarter-point increments wherever possible. In the statement from its meeting last June, the Fed said, "the risks are balanced with respect to the prospects" for "price stability" and "sustainable economic growth." Sure, job growth stalled last month and gross domestic product was revised downward. But the risks to "price stability" and "economic growth" do not appear to have changed dramatically enough to merit a radical departure from the Fed's transparency and gradualist policy-implementation goals. Keeping in character, the Fed will most likely broadcast its intention of lowering rates later in the year through a policy statement Tuesday, rather than cutting rates. If the Fed sticks to its guns and holds rates at 1.75%, debt futures -- which rally when the Fed cuts rates -- should fall from their recent highs. As I was writing this column early Thursday morning, September two-year (TUU2:CBOT), five-year (FVU2:CBOT) and 10-year notes (TYU2:CBOT) and T-bonds (USU2:CBOT) opened sharply lower and are still under water. Notice in this daily chart how T-bonds have failed to fill the Aug. 6 gap on a closing basis, an indication of weakness. On an intraday basis, T-bonds are struggling to climb above Wednesday's lows after popping lower, in an area that coincides with a 15-minute cluster of Fibonacci resistance. Resistance also resides at 107 18/32 and then at 107 27/32. These are areas to test the theory that the Fed will leave rates unchanged in August. The initial downside objective is 105 31/32. This week, the Treasury sold a large quantity of debt with disappointing results. The Treasury sold $40 billion of 10-year notes Wednesday, with a bid-to-cover ratio (a measure of demand) of just 1.29, the lowest in more than two years. On Tuesday, the Treasury sold $22 billion five-year notes with a bid-to-cover ratio of 1.76, the lowest in eight auctions. It's dangerous stepping in front of a freight train -- T-bonds are a momentum market -- but this measure of oversupply also works to favor shorts. If the Fed leaves rates unchanged, that also could dampen gold's recent upturn as higher rates work to keep inflation at bay. To update my levels from July 29 , when I forecasted a bounce from a three-month low before a resumption of a move lower, 317.7 to 318.1 stands out as resistance in December gold (GCZ2:COMEX). The September dollar index (DXU2:NYBOT) is showing resilience off its recent contract low. As I've mentioned before, I look for a "critical mass" of five or more gaps, expansion bars or laps within a one-month period to flesh out situations of potential nascent momentum. The following chart shows that this threshold has been achieved in the dollar index. The September British pound (BPU2:CME) is holding support at a tight clustering of three Fibonacci retracement levels and its 50-day exponential moving average, suggesting a bounce from the recent selloff. December wheat (WZ2:CBOT) remains one of the strongest momentum markets amid forecasts for the smallest U.S. and Canadian crops in more than a quarter-century. Clearly identified momentum markets make good candidates for Opening Range Breakouts, an entry method I've written about before. Finally, October live cattle (LCV2:CME) has also held support at the coincidence of its 50-day exponential moving average and 38.2% retracement of its June low. Also, notice that this market has traced a cup and handle, and that Tuesday it thrusted to almost match a three-month closing high.